Contractors Leaving Umbrella Companies
It may be time for British contractors to consider leaving umbrella companies.
Many contractors were just shoe-horned into them, anyway, against their best interests by agencies. some of those get bungs from umbrella companies for putting contractors their way.
This is especially true of new contractors who don’t know any better. Some agencies hit them.
First of all, the agency takes a huge margin from them (sometimes as much as 50%). Then they force them into umbrella companies, in order to get their own bung. That’s even though those contractors may well be outside IR35 – or could easily become so.
It is illegal under the 2010 Bribery Act for recruitment companies to induce contractors to join umbrella companies. However, this is widespread in the industry.
Contractors Using Personal Service Companies
Contractors who use personal service companies pay an average of £10,000 a year less tax than umbrella company contractors.
This rose in April 2016 when he Chancellor took away the right of contractors caught by the Intermediaries Act (IR35) from offsetting travel and subsistence expenses against tax.
Prism estimate this to cost IT Contractors £6,500 a year.
So, contractors who move from umbrella companies to personal service companies could be £15,000 a year better off if they jump ship.
If they used tax efficient limited companies the savings could be £25,000 a year after leaving umbrella companies.
Contractors Using Offshore Umbrella Companies
Then there are offshore umbrella companies which can return £25,000 to £30,000 more to current umbrella company contractors after leaving umbrellas companies.
We base the above figures on the average daily rate for an IT Contractor which is currently £425 a day or around £100,000 a year. That’s a nice round figure for calculation purposes.
Umbrella Company Contractors and IR35
However, umbrella company contractors must first determine if they are outside IR35. Alternatively they could change their contracts and working practices to get themselves outside IR35.
There are three major factors which determine whether UK contractors are inside of IR35 or ouside. If a contractor can prove himself, or herself, to be outside using these three major factors then they have gone a long way to being outside IR35.
So, how do umbrella company contractors know that they are outside IR35 or get themselves outside?
They have to prove that they have a contract for services like a service provider has rather than a contract of service like a permanent employee of a company has.
Control, Direction and Supervision as a Major IR35 Factor
If your client:-
1. gives you work,
2. tells you what to do,
3. tells you how much time it will take,
4. shows you how to do it and
5. supervises you while doing it,
then this is a pointer to a contract of service just like an employee of the company.
However, if you agree with the client:-
1. what you need to do, i.e. what you need to supply,
2. how long it should take,
3. work out by yourself what you need to do and
4. do not need supervision to get the piece of work done,
then this points to a contract for services (outside IR35) like an outside provider of services to the company.
If you are more like the second one then this points to you being outside IR35.
Change Your Contract and Working Practices
If you are more like the first one, then get a change made to your contract with the agency or client so that it reflects the second one.
Most agencies and clients will be happy to do so.
Also, you must change your working practices so that you agree mutually any work that you do and agree the amount of time needed to do it too.
You then need to workout by yourself how to do it and supervise it yourself till you hand over the piece of work you are to supply to your customerRidiculous IR35 Factor
This is the most ridiculous IR35 factor of all.
IR35 was set up to catch disguised employees. They were people who left work as an employee of a company on a Friday only to start as a contractor on a Monday at the same company and doing the same job.
This supposed disguised employee would be far less likely to need control, direction and supervision at that company than a contractor that this disguised employee took on, say, the week before doing the flip.
The chances are that the disguised employee needs no control, direction or supervison as he knows the company well. He may have been a Project Manager.
However, he may be directing the contractor whom he took on. He would be outside IR35, on his measure, and the contractor would be inside it.
Leaving Umbrella Companies – Mutuality of Obligation
This is the second major IR35 factor.
If there is an obligation for you to turn up and do the client’s work and an obligation for the client to pay you for the period in your contract, whether they have anything for you to do or not, then here is a Mutuality of Obligation between the two parties.
If you have a four week’s noticy clause in your contract, that points to an obligation for them to pay you even if the project phase is finished.
That is not good if you want to stay outside IR35 and keep £15,000, or more, of the money you earn.
Change Your Contract to Remove Mutuality of Obligation
If you don’t have that mutuality of obligation in your contract then that is fine.
If you do, then you will have to change your contract and your working practices. Make sure there is no longer any obligation on either side.
Just one thing to add as regards Mutuality of Obligation.
Try to get them to take you on for the project rather than for, say, three monhs or six months. That would point to you being a supplier of services for a piece of work rather than being a short term permanent employee for a set period.
Contracting Now More Risky
Of course it puts you more at risk.
If they don’t have the work ready for you, they could potentially send you home for a few days, unpaid, till they have the work ready for you.
If the project finishes early, they could potentially end your contract early.
Also, if they want to just get rid of you, they can do so without giving you any notice or any payment for a notice period.
As I say, changing your contract to having no mutuality of obligation puts you at more risk.
Being Outside IR35 Worth Extra Risk
However the rewards are high. You would get, perhaps, £15,000 a year or more on leaving umbrella companies. Also, you should be able to eat any lost days from extra income saved.
However, in practice, this is not likely to happen often.
Where you are most likely to miss out is if your contract gets terminated early That could be because you didn’t perform, they didn’t like your face or because the project just gets cancelled.
This does happen but it is on very much the minority of contracts where it happens.
As regards the circumstance where the project finishes early and they let you go early, yes, they have the option to do that.
However, be serious, how often do IT projects, or phases of IT projects, finish early?
Sent Home Because Work Not Ready
Also, it may happen that they don’t have work ready for you. They could, potentially, send you home for a few days, without pay, until they do.
This does happen. Somtimes they ask contractors to twiddle their thumbs for a day or two till a piece of work is ready for them to do.
However, I would suggest that, knowing the contractor’s nose will be put out of joint if he, or she loses a few days pay because someone else doesn’t have the work ready for them to do would be a powerful incentive for the Project Manager, and the person suppling the work, to make sure that they do have it on time.
So, of course, there is more risk to the contractor.
However, I would suggest that in a normal year, those times when a contractor could lose money from some of those clauses being invoked would be far less than the £15,000 to £30,000 a year that a contractor could save by using some other vehicle than an umbrella company.
In a pure bean count the umbrella company option would lose.
Right of Substitution
This is the third major factor pointing to IR35.
This one, because of a court decision, should be a doddle.
What you have to do is to supply the name(s) of a person or persons who could substitute for you at a company. That’s if you are off for some reason. It’s also if the client agrees to this person substituting for you.
You can easily write this person into your contract.
However, there would also be a clause where, when you are off, the client can decide whether to take this person or not.
Most times the client would not. They would then be happy to have the substitute clause in your contract knowng that they have the final say on whether the substitute is used or not.
Court Decision on Right of Subsitution
Most importantly, there was a court ruling that said that HMRC could not prove that the substitute would not have been used if the contractor was off.
There would have have to have been a time when the contractor was off, the client wanted to use the substitute and the substitute didn’t turn up for HMRC to be able to prove that the substitute clause in the contract was a sham.
As you know, in most contracts, this does not come up, i.e. the right of substitution is seldom invoked.
Even if it was, the client would have the choice on whether they used the substitute or not.
In most, if not all cases, they wouldn’t.
Leaving Umbrella Companies or Staying
So, there you have it. Leaving umbrella companies could be positive financially for contractors.
If you are using an umbrella company, you could be losing to the tune of £15,000 to £30,000 a year.
You may have been shoe-horned into one in the first place by an unscrupulous agency who just wanted their bung for putting you in there. You may have known no better.
However, with the right for umbrella companies to be able to claim travel and subsistence expneses against tax for their contractors gone, the financial gap is now so big that umbrella company contractors should reassess wheher they want to stay in the umbrella or use some other vehicle.
Other Tax Options for Contractors on Leaving Umbrella Companies
So, what vehicles can they use after leaving umbrella companies?
They could use a personal service company which could save them £15,000 a year.
They could use a limited company which uses efficient forward tax planning to cut contractors tax bills. These can return 85% to contractors.
Using Offshore Umbrella Companies
If contractors are happy with their umbrella companies, and happy to pay the extra tax, then they should stay with their umbrella companies.
If they are not, they should consider other solutions.
Leaving Umbrella Companies can save contractors quite a lot of money.
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